Scandals in Spain, Italy show euro’s vulnerability

Commentary: Voters fed up with austerity, corruption, depression

WASHINGTON (MarketWatch) — Markets appear to have bounced back from the euro “wobble” that opened the week, but the whiff of panic over political scandals in Spain and Italy was a reminder of just how fragile the peace in the euro zone is.

Weekend news reports fueled concerns about a slush-fund scandal in Spain that has undermined the country’s conservative government and brought further evidence that a possible bank fraud in Italy has tarnished the frontrunner in Italy’s national elections scheduled for later this month.

Center-left politician Pier Luigi Bersani has been hit with collateral damage from the scandal enveloping the Monte dei Pashci bank.

In addition to its impact on Italian elections, the suspected manipulations by Monte dei Paschi bank in Siena — which took place when European Central Bank President Mario Draghi was head of Italy’s central bank and responsible for its supervision — could impinge on his credibility just as the ECB is poised to take over supervisory responsibility for Europe’s biggest banks.

Draghi made a quick trip to Milan last week to brief Italy’s finance minister on the Bank of Italy’s worries over Monte dei Paschi when it discovered some unusual derivatives contracts in 2010. The suspicion now is that the bank used these contracts to hide losses. Reporters are sure to grill Draghi about the Siena bank at the ECB’s press conference later this week.

In Italy, the government of Prime Minister Mario Monti is under attack for its decision to bail out the bank, and former Prime Minister Silvio Berlusconi is using the brewing scandal to score political points in the election campaign.

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Berlusconi’s party is gaining in the polls at the expense of the Democratic Party of Pier Luigi Bersani, who was thought to have a lock on the election until this scandal broke. Monte dei Paschi, considered to be the oldest in the world, traditionally has been close to Bersani’s party.

Berlusconi has effectively used this attack, combined with a promise to repeal the highly unpopular and punitive new property tax imposed by the Monti government. If Berlusconi continues his late surge, he could block formation of a stable government and cast some doubt on Italy’s willingness to toe the line dictated by Brussels.

Meanwhile, Spanish Prime Minister Mariano Rajoy has seen his poll numbers plunge amid reports that he was among the politicians who received payments from a slush fund. He has countered that a list showing payments to him was doctored and that the scandal is a smear campaign.

But there are increasing calls for his resignation and even for new general elections as more details emerge. Rajoy was swept into power in late 2011 when Spanish voters blamed the impact of the euro crisis in Spain on Socialist Prime Minister José Luis Rodriguez Zapatero’s government.

Spanish Prime Minister Mariano Rajoy has been accused of receiving payments from a slush fund. He says it’s a smear campaign.

Since coming to office Rajoy has tried to maintain a balancing act of imposing austerity measures in Spain that would forestall more severe measures if the country had to seek a bailout from the European Union.

As in most other European countries, the political class in Spain has been decimated by the grinding euro
EURUSD, +0.0000%
crisis. Rajoy’s best protection is that the leader of the Socialist Party, Alfredo Perez Rubalcaba, is even lower in the polls than he is.

But as the improbable comeback of Berlusconi demonstrates, voters may be happy with less than perfect choices if they decide that the harsh austerity dictated by Brussels and Berlin may not be the best solution for their countries.

The political turmoil in southern Europe comes after reports surfaced in Germany late in December that Chancellor Angela Merkel’s government is planning an austerity cure for that country after its national elections in September.

However, any move by Germany to cut spending would quickly dampen growth across the continent. International Monetary Fund Managing Director Christine Lagarde responded to the report by pointedly reminding Germany that countries not under pressure from financial markets should not be in a hurry to cut their spending.

The mooted austerity plan may in fact just be political posturing to fend off opposition attacks on the government’s “failure” to balance the budget.

The bottom line is that the euro crisis is taking its toll on Germany, too, and Europe’s biggest and healthiest economy will experience its own volatile political swings in the run-up to September’s elections.

In this environment, another political scandal or another insolvent bank, whether in southern or northern Europe, could trigger a new sense of panic among global investors, who demonstrated this week how skittish they remain.

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